What is going on? The answer, in a nutshell, is hu-man nature – glorious, perverse, excitable, cantankerous but above all moody and changeable. A national economy is driven by the flow and ebb – the boom and bust – of its citizens’ collective mood swings. Here’s a primer on our economic schizophrenia – and why the Fed’s tough-love treatment makes sound economic sense:
When times get good, consumers grow openhanded. Not at first, but gradually. They begin to spend a little too much money. They buy that car, purchase the house or stereo they’ve wanted for oh-so-long. (Consumer spending this year has risen twice as fast as incomes.) Industry catches the fever, too. It hires a few extra workers, buys more factories and machinery than actually needed. (Private investment soared by 12 percent over the last six months – an unsustainable 24 percent annual rate – compared with just 1 percent the previous half year.) The result: a ripsnorting economic expansion.
Nothing, up to a point. But there’s something about an expansion that, before long, becomes too much of a good thing. At full employment, or whatever it structurally amounts to these days, the economy can’t produce anything more. When business can’t raise output, it raises prices. Hello, inflation. If left unchecked, it erodes savings, derails business plans, chokes off sound investment and, ultimately, stalls economic growth. The great inflation of the 1970s slashed average U.S. growth rates from 4 percent annually between 1947 through 1973 to only 2.3 percent since then.
Possibly. But governments are run by excitable people, too. From the president on down, they are elected officials – a.k.a. politicians – who like to be popular. Slow growth slows down good times. Left on their own, then, elected governments are lousy economic stewards. They act only after inflation runs loose. This political fact of life is well known to private investors and to the nonelected Federal Reserve, which controls the nation’s supply of money and credit. So the Fed and the securities markets are the true economic stabilizers, the flywheel whose job it is to keep booms (and busts) from getting out of hand. They’re doing that now. By pushing up bond, bank, and adjustable mortgage interest rates, they’re safeguarding our economic future.
Because financial markets and the Fed look ahead. They must. Bonds are bought and put away for many years; buyers therefore worry a lot about future inflation. When the economy heated up last fall, investors said, ““Oh, oh. Here we go again.’’ Ten-year bond interest rates rose from 5.3 to 7.6 percent (forcing prices down) before last week’s rally. As for the Fed, it can take six to 12 months for higher rates to slow bank lending, and hence slow business and consumer spending. Looking ahead, the Fed and the bond markets see a strong expansion with plenty of momentum. Putting on the brakes now is merely good sense. Indeed, the Fed may be a bit late.
Yep. No one knows for sure what unemployment rate might be considered ““natural.’’ After all, people are always changing jobs, getting laid off or leaving school. But Stuart Weiner, an economist with the Federal Reserve in Kansas City, Mo., recently figured it was as high as 6.75 percent. Laura D’Andrea Tyson, the president’s chief economist, puts it between 5.9 and 6.3 percent. Whatever, the United States is already at or very near full employment. That’s why the Fed and the financial markets want to cool it.
No. It’s just got to get better, slower. Economists believe the economy can grow as fast as 2.5 percent a year without triggering inflation. Clearly, last year’s 4 percent rate was way too high. If things don’t settle down by this fall, we could have a burst of inflation, followed by a recession in late ‘95. The more the Fed hesitates today, the greater the shock to our wallets tomorrow.
Yes. Wall Street’s happy week was an eloquent vote of confidence. The Fed’s decision to tap down on the credit markets wasn’t at all the ““bad news’’ Washington thought. It was good news for anyone who understands the economy.
